18-1 PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield 18-2 18 18 Revenue Recognition LEARNING OBJECTIVES After studying this chapter, you should be able to: 18-3 Understand revenue recognition issues Identify the five steps in the revenue recognition process Allocate the transaction price to the separate performance obligations Identify the contract with customers Identify the separate performance obligations in the contract Determine the transaction price Recognize revenue when the company satisfies its performance obligation Identify other revenue recognition issues Describe presentation and disclosure regarding revenue OVERVIEW OF REVENUE RECOGNITION Background Revenue recognition is a top fraud risk and regardless of the accounting rules followed (IFRS or U.S GAAP), the risk or errors and inaccuracies in revenue reporting is significant Recently, the IASB and FASB issued a converged standard on revenue recognition entitled Revenue from Contracts with Customers 18-4 LO OVERVIEW OF REVENUE RECOGNITION New Revenue Recognition Standard Revenue from Contracts with Customers, adopts an asset-liability approach Companies: 18-5 Account for revenue based on the asset or liability arising from contracts with customers Are required to analyze contracts with customers ► Contracts indicate terms and measurement of consideration ► Without contracts, companies cannot know whether promises will be met LO New Revenue Recognition Standard ILLUSTRATION 18-1 Key Concepts of Revenue Recognition Performance Obligation is Satisfied 18-6 LO 18 Revenue Recognition LEARNING OBJECTIVES After studying this chapter, you should be able to: 18-7 Understand revenue recognition issues Identify the five steps in the revenue recognition process Allocate the transaction price to the separate performance obligations Identify the contract with customers Identify the separate performance obligations in the contract Determine the transaction price Recognize revenue when the company satisfies its performance obligation Identify other revenue recognition issues Describe presentation and disclosure regarding revenue THE FIVE-STEP PROCESS Assume that Airbus (FRA) Corporation signs a contract to sell airplanes to Cathay Pacific Airlines (HKG) for €100 million ILLUSTRATION 18-2 Five Steps of Revenue Recognition A contract is an agreement between two parties Step 1: Identify the contract with that creates enforceable rights or obligations In customers this case, Airbus has signed a contract to deliver airplanes to Cathay Pacific 18-8 Step 2: Identify the separate Airbus has only one performance obligation—to deliver airplanes to Cathay Pacific If performance obligations in the Airbus also agreed to maintain the planes, a separate performance obligation is contract recorded for this promise LO THE FIVE-STEP PROCESS ILLUSTRATION 18-2 Five Steps of Revenue Recognition Transaction price is the amount of consideration Step 3: Determine the transaction that a company expects to receive from a customer in exchange for transferring a good price or service In this case, the transaction price is straightforward—it is €100 million Step 4: Allocate the transaction price to the separate performance obligations 18-9 In this case, Airbus has only one performance obligation—to deliver airplanes to Cathay Pacific LO THE FIVE-STEP PROCESS ILLUSTRATION 18-2 Five Steps of Revenue Recognition 18-10 Step 5: Recognize revenue when Airbus recognizes revenue of €100 million for the each performance obligation sale of the airplanes to Cathay Pacific when it satisfies its performance obligation—the is satisfied delivery of the airplanes to Cathay Pacific LO APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES FRANCHISE ACCOUNTING Performance obligations relate to: Right to open a business Use of trade name or other intellectual property of the franchisor Continuing services, such as marketing help, training, and in some cases supplying inventory and inventory management 18-118 LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES FRANCHISE ACCOUNTING Franchisors commonly charge an initial franchise fee and continuing franchise fees: 18-119 ► Initial franchise fee (payment for establishing the relationship and providing some initial services) ► Continuing franchise fees received In return for continuing rights granted by the agreement For providing management training, advertising and promotion, legal assistance, and other support LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES Facts: Tum’s Pizza Inc enters into a franchise agreement on November 1, 2015, giving Food Fight Corp the right to operate as a franchisee of Tum’s Pizza for years Tum’s charges Food Fight an initial franchise fee of $50,000 for the right to operate as a franchisee Of this amount, $20,000 is payable when Food Fight signs the agreement, and the balance is payable in five annual payments of $6,000 each on December 31 Food Fight also promises to pay ongoing royalty payments of 1% of its annual sales (payable each January 31 of the following year) and is obliged to purchase products from Tum’s at its current standalone selling prices at the time of purchase The credit rating of Food Fight indicates that money can be borrowed at 8% The present value of an ordinary annuity of five annual receipts of $6,000 each discounted at 8% is $23,957 The discount of $6,043 represents the interest revenue to be accrued by Tum’s over the payment period 18-120 LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES Identify the performance obligations and the point in time when the performance obligations are satisfied and revenue is recognized Rights to the trade name, market area, and proprietary know-how for years are not individually distinct Each one is not sold separately and cannot be used with other goods or services that are readily available to the franchisee 18-121 Combined rights give rise to a single performance obligation Tum’s satisfies performance obligation at point in time when Food Fight obtains control of the rights LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES Identify the performance obligations and the point in time when the performance obligations are satisfied and revenue is recognized Training services and equipment are distinct because similar services and equipment are sold separately Tum’s satisfies those performance obligations when it transfers the services and equipment to Food Fight Tum’s cannot recognize revenue for the royalty payments because it is not reasonably assured to be entitled to those royalty amounts 18-122 Tum’s recognizes revenue for the royalties when (or as) the uncertainty is resolved LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES Consider the following for allocation of the transaction price at December 31, 2015 Training is completed in January 2016, the equipment is installed in January 2016, and Food Fight holds a grand opening on February 2, 2016 18-123 LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES On December 31, 2015, Tum’s signs the agreement and receives upfront payment and note Cash 20,000 Notes Receivable 18-124 30,000 Discount on Notes Receivable 6,043 Unearned Franchise Revenue 20,000 Unearned Service Revenue (training) 9,957 Unearned Sales Revenue (equipment) 14,000 LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES On February 2, 2016, franchise opens Tum’s satisfies the performance obligations related to the franchise rights, training, and equipment Unearned Franchise Revenue Franchise Revenue 20,000 20,000 Unearned Service Revenue (training) Service Revenue (training) 9,957 Unearned Sales Revenue (equipment) Sales Revenue 9,957 14,000 14,000 Cost of Goods Sold 10,000 Inventory 18-125 10,000 LO 13 APPENDIX 18B REVENUE RECOGNITION FOR FRANCHISES RECOGNITION OF FRANCHISE RIGHTS REVENUE OVER TIME Depending on the economic substance of the rights, the franchisor may be providing access to the right rather than transferring control of the franchise rights In this case, the franchise revenue is recognized over time, rather than at a point in time 18-126 LO 13 APPENDIX 18B FRANCHISE REVENUE OVER TIME Facts: Tech Solvers Corp is a franchisor and provides a range of computing services (hardware/software installation, repairs, data backup, device syncing, and network solutions) on popular Apple and PC devices Each franchise agreement gives a franchisee the right to open a Tech Solvers store and sell Tech Solvers’ products and services in the area for years Under the contract, Tech Solvers also provides the franchisee with a number of services to support and enhance the franchise brand, including 18-127 (a) advising and consulting on the operations of the store; (b) communicating new hardware and software developments, and service techniques; (c) providing business and training manuals; and (d) advertising programs and training LO 13 APPENDIX 18B FRANCHISE REVENUE OVER TIME Facts: As an almost entirely service operation (all parts and other supplies are purchased as needed by customers), Tech Solvers provides few upfront services to franchisees Instead, the franchisee recruits service technicians, who are given Tech Solvers’ training materials (online manuals and tutorials), which are updated for technology changes, on a monthly basis at a minimum Tech Solvers enters into a franchise agreement on December 15, 2015, giving a franchisee the rights to operate a Tech Solvers franchise in eastern Bavaria for years Tech Solvers charges an initial franchise fee of €5,000 for the right to operate as a franchisee, payable upon signing the contract Tech Solvers also receives ongoing royalty payments of 7% of the franchisee’s annual sales (payable each January 15 of the following year) 18-128 LO 13 APPENDIX 18B FRANCHISE REVENUE OVER TIME Identify the performance obligations and the point in time when the performance obligations are satisfied and revenue is recognized Rights to the trade name, market area, and proprietary know-how for years are not individually distinct Each one is not sold separately and cannot be used with other goods or services that are readily available to the franchisee 18-129 Licensed rights and the ongoing training materials are a single performance obligation Tech Solvers is providing access to the rights and must continue (over time) to perform updates and services LO 13 APPENDIX 18B FRANCHISE REVENUE OVER TIME Identify the performance obligations and the point in time when the performance obligations are satisfied and revenue is recognized Tech Solvers cannot recognize revenue for the royalty payments 18-130 Not reasonably assured to be entitled to those revenue-based royalty amounts Payments represent variable consideration Recognize revenue for royalties when (or as) uncertainty is resolved LO 13 APPENDIX 18B FRANCHISE REVENUE OVER TIME Franchise agreement signed and receipt of upfront payment and note, December 15, 2015: Cash 5,000 Unearned Franchise Revenue 5,000 Franchise begins operations in January 2016 and records €85,000 of revenue for the year ended December 31, 2016 Unearned Franchise Revenue 1,000 Franchise Revenue (€5,000 ÷ 5) Accounts Receivable 5,950 Franchise Revenue (€85,000 x 7%) 18-131 1,000 5,950 LO 13 COPYRIGHT Copyright © 2015 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 18-132 ...PREVIEW OF CHAPTER Intermediate Accounting IFRS 2nd Edition Kieso, Weygandt, and Warfield 18- 2 18 18 Revenue Recognition LEARNING OBJECTIVES After studying this chapter, you should be able to: 18- 3... ILLUSTRATION 18- 1 Key Concepts of Revenue Recognition Performance Obligation is Satisfied 18- 6 LO 18 Revenue Recognition LEARNING OBJECTIVES After studying this chapter, you should be able to: 18- 7 Understand... is separately sold and is not interdependent 18- 27 LO 18 Revenue Recognition LEARNING OBJECTIVES After studying this chapter, you should be able to: 18- 28 Understand revenue recognition issues